$41B Pa. pension shortfall looms over school, state budgets

As school districts across Pennsylvania prepare their budgets for the coming year and anxiously await Gov. Tom Corbett’s 2013-14 budget proposal, one issue looms larger than all the rest combined — pensions.

Reeling under the burden of investment losses during the 2009 economic collapse and years of under-funding, the state’s two major pensions are under-funded by a combined $41 billion.

As a result, the state and school districts face a steeply climbing schedule of payments that is consuming much of the additional revenue the state has seen in the current year’s budget and even more of the small slice of discretional spending school boards have control over in their annual spending plans.

And given that Act 1, enacted in 2006, prevents school districts from raising property taxes beyond a state-set cap without voter approval, most school boards find themselves caught between a rock and a hard place — the hammer of rising pension costs they can’t control that do nothing to contribute to the educational program, and the anvil of a revenue cap they can’t exceed without getting district voters to agree to raise their taxes even more — something that has never happened in Pennsylvania.

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Corbett — who will make the resolution of what he and his budget secretary Charles Zogby call “The Pennsylvania Pension Crisis” the centerpiece of his 2013-14 budget proposal — likes to refer to the pension costs for the State Employees’ Retirement System (SERS) and the larger Public School Employees’ Retirement System (PSERS) as “the tapeworm in the budget.”

The problem is serious enough, he told The Philadelphia Inquirer last week, that although he does not intend to cut funding to public schools in the budget he will reveal on Feb. 5, failure to reform the two pension systems may leave him little choice.

Laying the groundwork for that discussion, Corbett and Zogby have been meeting with newspaper editorial boards in recent weeks to lay out the problem and how we got there.

The pensions are ones seen with less frequency in the private sector and are called “defined benefit plans,” which Zogby described as “almost a dinosaur” when compared to the benefits offered in business environments around the country.

As the name suggests, they guarantee a certain amount of money upon retirement.

By contrast, retirement plans in the private sector are often the “defined contribution plan” variety.

Using vehicles like tax-deferred 401(k) plans, these plans only guarantee how much will be contributed to a plan and leave the result, and ultimate pension payout, to market forces and investment strategies.

Although he did not say he will propose this, Corbett and Zogby did discuss how defined contribution plans could be implemented for new education employees during a Jan. 10 meeting with editorial staff from Digital First Media newspapers.

They also hinted that Corbett’s pension reform proposal may involve changing the formula — called “the multiplier” by those familiar with the system — which helps determine how large a pension any given employee will receive upon retirement.

According to Zogby’s briefing, both pension systems have three major sources of revenue — contributions by the employees, which accounted for 19 percent of revenue over the past 10 years; contributions from school districts and the state, which are divided evenly and account for another 10 percent of revenue; and 71 percent from investment earnings.

Since a “defined benefit” determines what comes at the end of the “equals” sign in this equation, the only variable that can be altered to ensure that result is the contributions.

Without control over the stock market, employee and employer contributions remain as the primary part of the plan that can be altered.

Missing market performance targets were almost guaranteed by the fact that on the heels of “a spectacular decade of investment” in the 1990s, the market investment revenue expectation was set at an unrealistic 7.5 percent return, Zogby said.

With the pension obligations “100 percent funded” as the new century dawned, the Pennsylvania Legislature and Gov. Tom Ridge increased their retirement benefits, as well as those of the educators and state workers, by increasing the “multiplier” formula and doing so retroactively.

Then came the Sept. 11 attacks in 2001 “and the economy didn’t come back,” said Zogby.

Faced with “the spectre of really significant spikes in employer contribution rates” to fill a growing gap between obligations and revenues, the Legislature instead “engaged in artificial suppression of employer contributions,” leaving both pension funds under-funded by $5.9 billion, said Zogby.

That gap was compounded each year the caps kept revenues below obligations and then adding the new year’s shortfall on top of that.

“The state was only paying in 60 percent of what it should have,” Zogby said, adding that the dive in investment revenue in 2009 “was just the cherry on the sundae.”

“The people who came before us did not do what they were supposed to do,” said Corbett.

“Ultimately,” Zogby said, “it is the taxpayers who bear the risk of this plan” because, whether through state income taxes or local school district property taxes, taxpayers pay for legally obligated commitments to make the plan whole again.

“This is an obligation that’s owed,” said Zogby. “There’s nothing we can do to avoid this. This is a debt that has to be paid.”

Some attempts have been made to address the growing problem, attempts Corbett described as “nibbling around the edges.”

In 2010, the Legislature adopted Act 120, which reduced benefits for new employees, increased the retirement age and eliminated the ability to withdraw pension earnings in one lump sum.

However, that act also capped the contributions by employers. That cap was not high enough to cover the cost of the plans’ increasing obligations.

The Pennsylvania State Education Association, the primary teachers union in Pennsylvania, has taken the position that any changes Corbett proposes must provide savings greater than the 3 percent realized under the changes made in Act 120.

In an Aug. 14 statement, PSEA President Michael Crossley pointed out that “school employees pension benefits have not gone up and the school employees never stopped paying their 7.5 percent of salary toward their pensions, even with the Commonwealth not making adequate payments over the last 12 years.”

And while it’s unlikely that the Corbett administration and PSEA will quickly agree on new pension rules, both agree on the effect of Act 120, with both Zogby and Crossley describing the bill as “kicking the can down the road.”

That agreement also reaches down to the local school district level.

“The responsibility is with the state legislators ... they should have kept the rate at a higher rate and they did not,” Spring-Ford Business Manager Timothy Anspach told his school board during a Jan. 22 review of the proposed budget for the coming school year.

“And then we get grief because we have to raise taxes,” said Spring-Ford school board member Tom DiBello.

In fact, while there may not be much agreement over solutions, there is near universal agreement on the scope of the problem.

In addition to the Corbett administration and the PSEA, the Pennsylvania School Boards Association has weighed in, circulating a suggested resolution for school boards to adopt which notes “meaningful solutions to these problems must involve identifying another funding source for PSERS, decreasing or cutting the costs and liabilities of the system, including benefit levels, and examining the possibility of adoption of a hybrid pension plan that would reduce employer costs over time.”

Even the free-market Commonwealth Foundation is singing the same song.

In a Jan. 18 commentary, the group’s director of policy analysis, Nathan Benefield, wrote that pension costs had already resulted in layoffs of nearly 6,000 teachers and could increase costs for the average Pennsylvania homeowner by $348.

Those costs, however, would vary widely he wrote “from as low as $102 in the Saint Clair Area district to $882 per homeowner in Reading City School District.”

“Many families will pay more than $1,000 in additional taxes for pension debt we accumulated over the past decade and get nothing more for their money,” wrote Benfield.

As for solutions, that’s where it will get tricky.

And Corbett has made it plain he knows this.

Both he and Zogby recognized that changing the benefits for those in the system will be a difficult thing to accomplish.

“There is a difference of opinion in how far you can change benefits for current employees,” said Zogby, adding, “but no matter what we do with the current employees, it will be litigated.”

Resolving the problem will take effort from school boards, teachers unions, state employee unions and the legislature, Corbett said.

“Everybody has to participate in the solution,” Corbett said, although he and Zogby acknowledged during the Jan. 10 meeting with Digital First Media that they had not yet put out any feelers to the others who must sit at the table to get their input.

“There are some mechanisms” for a solution “that will not be popular, but they will have to be looked at,” said Corbett.

For example, he said, trying to “re-set the multiplier” which increases the amount of a final pension would be “a huge battle.”

But if that were to be the path taken, it would not be retroactive, he said.

“It would not be a cut. You wouldn’t lose what you’ve got,” Corbett said of those in the pension system. It would be “a readjustment of what you’d get going forward.”

As Zogby noted, “most Pennsylvanians don’t have a guaranteed retirement benefit,” a sentiment echoed by Spring-Ford School Board President Joe Ciresi last week when he said “no one paid me back the 40 percent I lost in my 401K.”

However, one option Corbett seems disinclined to pursue is a tax hike to increase contributions — at least at the state level.

“We have to have an avenue out of this mess, and it can’t just be tax increases,” he said.

“I don’t think you can raise taxes enough to fix this,” he said, adding that it was his insistence on holding the line on taxes that was contributing to the recovery of Pennsylvania’s economy.

In the 19-page pension report Zogby’s office issued in the fall, the administration laid out five guidelines it hopes to follow in pursuit of a solution.

They include “put taxpayers first; do no harm to retirees; respect current employees; achieve intergenerational fairness and learn from other states.”

Actions other states have taken and which “Pennsylvania might consider,” include increased employee contributions; raising the retirement age; changing the multiplier; providing incentives to leave the system early; or changing from a defined benefit to a hybrid or defined contribution plan.

In the end, said Zogby, those at the table will have to choose the “most palatable of a set of ugly options.”

“None of this is pain free,” he said, “but I think the taxpayers have reached their maximum level of pain in terms of school cuts.”

About the Author

Evan Brandt has worked for The Mercury since November 1997. His beat includes Pottstown, the surrounding townships and the Pottstown and Pottsgrove school districts, as well as other varied general topics like politics, the environment and education. Reach the author at ebrandt@pottsmerc.com
or follow Evan on Twitter: @PottstownNews.